Demand Elasticity
IMELDA B. CUETO
Managerial Economics
Colegio de San Juan de Letran
SBMA
Learning Objectives
Explain the nature and characteristics
of demand elasticity
Describe the determinants of demand
elasticity
Calculate and analyze elasticity
Explain the applications and
importance of demand elasticity
ELASTIC
capable of ready
change or easy
expansion or
contraction
not rigid or
constricted
ECONOMIC ELASTICITY IN DEFINED
AS …..
The responsiveness of a dependent
economic variable to changes in
influencing factors.
What is Demand Elasticity
Demand elasticity refers to the reaction or
the response of the consumers to changes in
determinants of demand such as:
Price – Price Demand Elasticity
Income – Income Elasticity
Price of related products – Cross Price Elasticity
Types of Demand Elasticity
Price Elasticity – Buying responses of consumers
to price changes.
•Income Elasticity - Buying responses of consumers
when their incomes change
•Cross Price Elasticity - Buying responses of
consumers of one product when the price of another
product changes
Factors Affecting Demand Elasticity
Availability of Close Substitutes
Substitute goods are goods that can be used in
activities aimed to satisfy the same needs, one in
the place of another.
Factors Affecting Demand Elasticity
Availability of substitute goods:
The larger the number and closer the substitutes
available, the higher the elasticity is likely to be,
as people can easily switch from one good to
another if an even minor price change is
made. There is a strong substitution effect.
If no close substitutes are available, the
substitution effect will be small and the demand
inelastic.
Factors Affecting Demand Elasticity
Proportion of Income spent on the product
The higher the percentage of the consumer's income
that the product's price represents, the higher the
elasticity tends to be, as people will pay more
attention when purchasing the good because of its
cost .The income effect is substantial.
When the goods represent only a negligible portion
of the budget the income effect will be insignificant
and demand inelastic.
Factors Affecting Demand Elasticity
Luxuries and Necessities
The more necessary a good is, the lower the
elasticity, since people will buy it no matter the price,
such as the case of insulin for diabetics.
Demand for necessary goods increases as
income rises, but at a rate slower than the rate of
increase in income. A normal good for which the
income elasticity of demand is positive but less
than one, hence, inelastic income elasticity.
Factors Affecting Demand Elasticity
Time horizons
The product demand is more elastic the longer the time
period . Consumers need time to adjust to changes in prices.
The longer a price change holds, the higher the elasticity is
since consumers find they have the time and inclination to
search for substitutes.
When fuel prices increase suddenly, consumers may still
fill up their empty tanks in the short run. But when prices
remain high over several years, more consumers will reduce
their demand for fuel by switching to carpooling or public
transportation, or investing in more fuel-efficient vehicles.
Factors Affecting Demand Elasticity
Brand Loyalty
An attachment to a certain brand—either out of
tradition or because of proprietary barriers—can
override sensitivity to price changes, resulting in
more inelastic demand.
Demand Elasticity
PRICE ELASTICITY
OF
DEMAND
UNITARY ELASTIC
PERFECTLY INELASTIC
Perfectly inelastic means that
quantity demanded is
unaffected by any change in
price. The quantity is
essentially fixed and it does
not matter how much price
changes, quantity does not
budge.
Perfectly inelastic demand
occurs when buyers have no
choice in the consumption of a
good.
PERFECTLY INELASTIC
In case of necessities such as staple food grains, no
matter how much the price rises or falls, the quantity
demanded by an individual would remain the same -
the consumer will not start eating more if grains
become cheaper nor would he reduce his consumption
if they become dearer.
In case of an increase in the price of such a necessity,
the consumer may cut down on the consumption of
other commodities to adjust his budget such that the
same quantity of food grain is absorbed despite a rise in
price.
Demand Elasticity
INCOME ELASTICITY
OF
DEMAND
Income Elasticity of Demand
Income elasticity of demand measures the
relationship between a change in quantity demanded
for good X and a change in real income. The formula
for calculating income elasticity is:
Income Elasticity of Demand
A commodity is said to have a
perfectly inelastic demand if
the quantity demanded or
consumed of it does not
respond to a change in the
income of the consumer.
Such commodities are usually
known as sticky goods and
consist mainly of necessities.
Income Elasticity of Demand
Income Elasticity of Demand
Normal goods have a positive income elasticity of demand so as
consumers' income rises more is demanded at each price i.e. there is an
outward shift of the demand curve.
Normal necessities have an income elasticity of demand of between 0
and +1 for example, if income increases by 10% and the demand for
fresh fruit increases by 4% then the income elasticity is +0.4. Demand is
rising less than proportionately to income
Luxury goods and services have an income elasticity of demand >
+1 i.e. demand rises more than proportionate to a change in income –
for example a 8% increase in income might lead to a 10% rise in the
demand for new kitchens. The income elasticity of demand in this
example is +1.25.
Income Elasticity of Demand
Inferior goods have a negative income
elasticity of demand meaning that demand
falls as income rises.
Inferior goods or services exist
where superior goods are available if the
consumer has the money to be able to buy it.
Income Elasticity and Engel’s Curve
Named after 19th Century German statistician Ernst Engel,
showing the relationship between consumer demand and
household income.
People spent a smaller and smaller portion of their income
on food as their income increases.
Engel curves for normal goods slope upwards – the flatter the
slope the more luxurious the good, and the greater the income
elasticity.
Engel curves for inferior goods have a negative slope.
The Engel’s curves show the
demand for the three goods
and each responds
differently to the same
change in income, increase
from Y to Y1.
Demand for the normal
good increases from Q to Q1
Demand for the luxury good
rises much more, to Q2
Demand for the inferior
good falls from Q to Q3.
Engel’s Curve
Demand Elasticity
CROSS PRICE ELASTICTY
Formula for Cross Price Elasticity
Cross Price Elasticity
Cross Price Elasticity
Cross Price Elasticity
Substitutes or
Complementary?
Explain your answer
using the cross price
elasticity concept.
REFERENCES
Mankiw, G.N., (2012). Essentials of Economics 6 th Edition. Harvard University: South-
Western, Cengage Learning
Mastrianna F.V.(2013).Basic Economics 16th Edition. South-Western Cengage Learning
McConnel, C. et.al (2012). Economics: Principles, Problems, and Policies (Global Edition).
McGraw Hill Co., Inc.
Paraiso O.C. et.al (2011). Introduction to Microeconomics, Mutya Publishing House, Inc.
Stock W.A., (2013) Introduction to Economics: Social Issues and Economic Thinking
Web Sites:
http://www.amosweb.com
http://beta.tutor2u.net/economics/
http://www.buzzle.com/
http://economicswebinstitute.org
https://ph.images.search.yahoo.com
http://www.merriam-webster.com
http://en.wikipedia.org/
